finding the best liquidity in dark pools
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© 2009 Investment Technology Group, Inc. All rights reserved. Not to be reproduced or retransmitted without permission. Brokerdealer products and services offered by ITG Inc., member FINRA, SIPC. POSIT Marketplace accesses, among other destinations, the POSIT Now and POSIT Match ATSs. 04170940099
Rising to the Top: Finding the Best Liquidity in Dark Pools
Hitesh Mittal, Managing Director Investment Technology Group
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Dark Pools Are a ZERO SUM Game
• Traditional dark pools invited likeminded participants • The objective was to minimize impact
• Newer entrants tend to invite a wider variety of participants with different objectives:
• Institutions – minimize impact • DMA flow – reduce cost • Market makers, prop desks, and high frequency funds – earn short term alpha
• Dark pools are a ‘zero sum game’ by construction • The objectives of newer entrants make them less attractive to institutions
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How to Extract Quality Liquidity
Understand contratypes in
dark pools
Separate contratypes in dark pools
Measure performance and contratypes in dark pools
Optimally allocate to minimize
Implementation Shortfall
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Understanding ContraTypes
Gamers
Institutional Market Bound
High Frequency Market Makers
Institutional Block Order
Minimizes Impact
May Support Stocks
No Spread Savings Adverse Selection
Gaming
*Based on internal ITG research: “Are You Playing in a Toxic Dark Pool? A Guide to Preventing Information Leakage,” Hitesh Mittal, Journal of Trading, Summer 2008.
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Separating ContraTypes
Avoids gamers by not allowing orders to get pinged
Uses minimum size on orders
Uses order type Peg Passive without min size
Shuts down IOIs by sending small aggressive
orders
Large Client Order
ITG’s Liquidity Filter technology uses this logic to interact intelligently against each type of liquidity
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Understanding Implementation Shortfall
Total Implementation Shortfall = execution cost vs. arrival + potential cost of executing the residual order based on the current stock price
3bps IS of executed shares
7 bps Opportunity Cost
Example: Buy 100k ABC Executed shares: 35k Unexecuted shares: 65k
5.6bps 7bps 3bps
Total Implementation
Shortfall
Opportunity Cost
IS of Executed Shares
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How to Measure Performance of a Dark Pool
• Implementation Shortfall of executed shares
• Fill rate
• Adverse selection
• Opportunity Cost: the cost of trading unexecuted shares
• Implementation Shortfall + Opportunity Cost
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Time Price
§ Fill rate: 50% Great!!
§ IS cost on fills: Negative Great!!
§ Opportunity Cost: High Not Great
§ Total IS cost:
(IS Cost + Opportunity Cost) High Not Great
5 bps
10 bps
15 bps
5 bps
10 bps
15 bps
Example: 6 Buy Orders
Looking at Fill Rates Alone is Not Enough
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Time Price
• Fill rate: 25% OK
• IS cost on fills: 0 OK
• Opportunity Cost: 0 Great!!
• Total IS Cost:
(IS Cost + Opportunity Cost) 0 Great!!
Looking at Fill Rates Alone is Not Enough
Higher adverse selection = Higher opportunity cost
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Adverse Selection Across Dark Pools
Adverse Selection End Time +1 min
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Optimally Allocate for Best Performance
• Spreading orders across multiple pools leads to more information leakage
• Higher information leakage = Higher IS cost
• Allocation should be adjusted based on • Adverse selection • Average impact in each pool • Average fill rate in each pool
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Introducing POSIT Marketplace SM
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ITG’s Liquidity Filter At the Core of POSIT Marketplace SM
Separate toxic and nontoxic contras in dark pools
Measure the performance of each dark pool and contra
Allocate first to highest quality dark pools and contras
Measure total IS of orders and adjust
allocation
13
Disclaimer
These materials do not provide any form of advice (investment, tax or legal). Neither Investment Technology Group, Inc. nor ITG Inc. is a registered investment adviser and they do not provide investment advice or recommendations to buy or sell securities, to hire any investment adviser or to pursue any investment or trading strategy.
The screen shots provided in this presentation represent examples of certain products available from ITG. They contain sample data and are provided for informational purposes only. All functionality and delivery estimates described herein are subject to change without notice.
These materials are highly confidential and are not to be copied, displayed or transmitted in any form without the prior written permission of ITG.
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